China move like history in slow-motion
Asked about 175 years after the fact what he made of the French Revolution, Chinese Premier Zhou Enlai is said to have thought for a moment and concluded: “It is too soon to tell.”
Tell a U.S Congressman up for reelection or an unemployed auto parts worker in Ohio the same thing about China’s new policy to give the yuan more latitude in how it trades against the dollar and, once you’ve picked yourself up off the ground, you’ll have a different answer.
China on Saturday said it would end the yuan’s currency peg to the dollar, allowing it to trade more freely. It also made clear that no big move was forthcoming, preparing the way instead for “gradual” appreciation.
From a Zhou Enlai-like Olympian perspective this is a move in the right direction and, probably, helps to set the stage for a slow-moving but profound transformation in China’s economy and how it interacts with the rest of the world.
This is positive on many levels; it spreads the effects of Chinese growth more widely, it helps, at least a little, to rebalance global trade and, though they won’t be thankful for it, it gives U.S. consumers one more reason to not stuff itself with subsidized goods they so manifestly cannot afford.
What it is not is nearly fast enough.
While the yuan on Monday moved the most since its 2005 revaluation, analysts are generally forecasting a 5 percent appreciation in the coming year. Financial markets are looking for considerably less; offshore futures on Monday were betting on only a 2.6 percent move in the same period.
If you accept the analysis of the Peterson Institute that the yuan is 24 percent undervalued, then we could be looking at nearly a decade before we reach something like a fair rate of exchange.
I don’t think that is nearly soon enough to escape a prospectively very nasty round of trade tensions, tensions that may start between the United States and China but do not have to be limited to that thorny relationship. Regardless of the great drift of history, the U.S. unemployment rate is still going to be something close to 10 percent come the election this autumn.
By the time the yuan actually appreciates by 25 percent, the United States would have a very serious long-term unemployment issue. While it is clear that this was a hard won concession ahead of the Group of 20 meeting, you can expect congressional rhetoric to shift up a gear in very short order.
2005 WAS A DIFFERENT WORLD
To be sure, the yuan is already up 3.8 percent so far this year on a trade-weighted basis, courtesy of a shrinking euro. But while this may make Chinese officials loath to take big steps, it is actually one of the principal arguments for why they ought to act more quickly.
The world is in a period where the principal threats are deflation and huge capacity under-utilization.
The recession in the weaker parts of the euro zone currently being engineered to stave off a financing crisis means that pressure in the coming year over who sells what to whom will only grow. China would do well to not use Europe as an excuse, but rather try to get out in front.
Analysis of how much we should expect by way of yuan appreciation seems mostly to be rooted in the experience of 2005, when a revaluation of the yuan ushered in a one-year move of 3.6 percent and a two-year appreciation of a little less than 8 percent.
However 2005 was a very different time and China should not expect what played then to play now. The world was booming, U.S. unemployment was a shade over 6 percent and the talk in the euro zone was of convergence rather than a desperate fight to not break apart.
“Unless there is a fundamental change in China’s mode of development, it will be difficult to see the world not slipping into increased protectionism and every country/region having to fend for itself,” Diana Choyleva of Lombard Street Research wrote to clients.
“Even the Great Recession and China’s decisive domestic demand recovery were not able to do more than cut China’s current account surplus to 5.8 percent of GDP in 2009 from a peak of 10.6 percent of GDP in 2007.”
Expect too for the initial euphoria in financial markets to dissipate quickly as politics and reality intrude.
China has done fantastically out of globalization, but has been lucky enough to do it mostly on its own terms.
That luck might not hold.